The Planets Are Lining Up Nicely for Gold

A few key factors are decidedly bullish. Here's what to look for:

Gold prices have been maddeningly erratic since the middle of last year, when their parabolic rally finally stopped at nosebleed highs. Since then, euphoria has been taken out of the equation, leaving only supply/demand and currency fluctuation as the key drivers of gold prices. Still, those two factors alone are enough to keep traders from getting comfortable.

So what does the supply-and-demand trend look like now, and to what extent will the volatile U.S. dollar shake things up going forward?

Great questions.

First Things First

Gold futures were in a funk in the second quarter of this year, with prices falling from $1,677 to $1,604 per ounce — though they ultimately had fallen from a March peak of $1,801 before making a bottom around $1,536. However, we didn’t fully understand why the plunge was happening until early August, when the World Gold Council reported that — surprise! — demand hadn’t slacked as much as first presumed.

Click to Enlarge Globally, real purchases of gold (by weight) were only off 9.7% in calendar Q2 compared to Q1’s demand. The bulk of the blame for gold’s demise goes to the U.S. dollar, which appreciated in value by 3.3% in the second quarter of this year.

Things decidedly changed in Q3 across the board.

Last quarter, global demand for gold reached 1,087 tonnes, up from the 990 metric tons consumed in the second quarter.

Bullish for gold? You bet. Gold soared from a price of $1,604 per ounce to $1,774 … a 10.5% romp — one aided by the fact that the U.S. Dollar Index fell 3% during that time.

Great, but what’s that got to do with where gold is now (or where it’s headed)?

Quite a bit, actually. Above all else, it simply confirms that gold is indeed trading based on fundamentals again … real buying, and real relative valuation against the sawbuck.

That’s not to say the fundamentals aren’t squirrelly — the central banks that bought 97 tonnes’ worth of gold last quarter might have made a colossal error in judgment. But the consumption jives with price and supply (and the dollar), meaning we can have more than a little faith that our assumptions will actually mean something. On that note …

Just the Facts

Here’s what we know as of today:

The U.S. dollar is trending lower as of last week, countering the rally that took hold back in mid-September. It’s still too soon to make a definitive call on whether the past few days are just a bearish blip in the midst of a rally, or the beginning of a new downtrend. As it stands right now, though, we have to assume the apparent trend is “the” trend. That means the dollar is sinking, which is bullish for gold.

Consumption is trending higher. Granted, we’ve only seen an uptick in quarter-to-quarter consumption of gold for just one quarter now — Q3’s 9.8% jump in demand vs. only a 2% contraction in supply. But again, we have to assume the current trend will remain in place until we can clearly see it’s not. More than that, we’ve not heard or seen concern from any of the usual buyers about gold no longer being worth purchasing … even if only purchased to make jewelry. This also is bullish for gold.

Putting two and two together, and assuming the supply remains stable — and the supply is easily the most stable part of the equation — all of the puzzle pieces here bode well for gold’s foreseeable future.

Price Targets

To the extent gold can and should have price targets, though, the $1,800 mark might be the ideal checkpoint target, meaning there’s a known ceiling there that has capped rallies in the past. If and when gold prices can hurdle the $1,800 mark, the next logical (and realistic) price is likely to be somewhere around the $2,000 level, assuming the rally unfurls at an average pace. That’s where a key resistance line (red, dashed) will be by the time it can be tested again, and would represent a sizable 14% gain for gold from its current price.

Just watch out for any move under that support side of the rising trading range, currently at $1,640. Any pullback beneath that floor could set off a bearish chain reaction.

But that’s a low-odds possibility at this point.

As of this writing, James Brumley did not hold a position in gold, gold futures, gold stocks or gold funds.